SEC Delays Rating Agency Reform Rules

The Securities and Exchange Commission (SEC) last Wednesday delayed a resolution on adopting rules that related to the regulation of credit rating agencies. The Commission will return to the issue on Dec. 3.

Back in October 2006, President George W. Bush signed the Credit Rating Agency Reform Act of 2006 (CRARA) into law. This made substantial changes intended to revamp the rating agency business model. The law puts the SEC in charge of issuing rules regarding registered credit rating agencies' conflicts of interest and the misuse of public information.

As part of its mission, the SEC released proposals concerning rating agencies last June, and opened them for public comment. Under these proposals, registered rating agencies would be required to disclose information that would improve transparency, such as conflicts of interest, procedures and methodologies used in determining credit ratings, and performance measurement statistics over varying periods of time.

Although the securitization industry has generally welcomed these changes, rules that the SEC has proposed requiring Nationally Recognized Statistical Rating Organizations to create a unique rating system - complete with new and separate symbols - for structured finance products, have been met with some opposition.

For instance, the Commercial Mortgage Securities Association (CMSA) has been working with regulators on rating agency reform by urging policymakers to consider additional transparency measures regarding ratings agency methodologies.

The CMSA supports the concept of a revised framework to ensure that rating agencies do not engage in unfair, coercive or abusive practices. "The CMBS market relies upon credit ratings in the pricing of CMBS products, so a level playing field for all rating agencies and vigorous competition in the industry will help ensure the most accurate ratings at competitive prices," a statement on the CMSA Web site said.

However, the association specifically opposes proposals to differentiate ratings for structured finance products. In its numerous comment letters, the CMSA has cautioned that the launch of a separate system would create undue confusion for investors.

"We are opposed to differentiation of structured finance," said Brendan Reilly, senior vice president in government relations at the CMSA. "This is in part because the aim is to give more information to all segments interested in these securities, specially investors that need to know about the ratings. The use of a new symbol would create confusion and implementation issues for investors."

Ratings, such as triple-A, have always been based on the premise that the borrowers backing those bonds are going to pay their loans. Therefore, placing a structured finance symbol or any kind of symbology before these ratings will only promote confusion on what these ratings actually mean.

In terms of implementation, uncertainty regarding the meaning of the ratings would basically mean that investors such as mutual and pension funds might have to revisit certain investment guidelines which require them to only buy triple-A or investment-grade securities, which will take a long time and creates additional confusion in the long term.

Reilly said that assigning a symbology within structured finance that would cover all different asset classes such as RMBS, CMBS, student and auto loans delivers the information in a way that is overly simplistic. He added that these asset classes have different characteristics that would be lumped together, be made too general and wouldn't appropriately characterize the rating. As an alternative, Reilly said that there has to be "transparency about the underlying methodologies used by these credit rating agencies as opposed to just placing a symbol."

With the postponement of any final ruling on this issue by the SEC, many questions remain unresolved. However, the general feeling, according to sources, is that the planned language requiring a new system won't be included in the final rules.